Building wealth, is building assets.
I have already said that it does not matter how you make your money, it is what you do with your money that will make you wealthy. If you want to become wealthy, you have to buy assets with your money.
The four asset classes are Cash, Property, Stocks or Shares and Derivatives.
We start of with cash.
The first reason is that we need an emergency fund. Money immediately available when we need it for some emergency. Since it must be immediately available, we do not want the risk of capital losses. Typically we will save cash for an emergency fund in a bank account or perhaps a Money Market fund.
The problem with cash is that it is low risk and very low returns. So we do not want to have too much money in cash. Too mitigate the problem, we will keep some money in a call account (immediate access, low interest) and some in notice accounts (higher interest, available after a specified time). Money Market Funds will have a higher interest rate and if we need the money, we can have it within seven working days (mostly).
If I had to make a rule, I would say keep as little as possible and as much as needed in cash. Traditionally we keep between three and six months of our expenses in an emergency fund. Optimize the interest that you earn.
We also use cash investments for saving for short term goals, like vacations or special thing we want to do or buy.
Bonds, like Government Bonds, are also considered as cash. Since the capital will fluctuate in correlation to the interest rate, it is not a good investment for an emergency fund. Since the interest is normally high and fixed, once you are invested, it is a good source of retirement income. The Government back these bonds, which also means you will always get your initial capital back at maturity. Government Bonds are considered risk free.
Recently a 38 year old guy with 107 properties said: “It is always too late to buy properties. It always too soon to sell properties.” Selling my properties when I did was my biggest financial mistake.
Property is a long term investment. I am not talking about your own house or vacant land. I am talking about properties that you can rent and earn an income from. If you can earn an income from vacant land, then we can include it.
Property is for most people the key to wealth.
Property has the following benefits:
- You earn an income from the property when you rent it out;
- You enjoy capital growth on the property while you own it;
- You can gear it – in other words, you can BORROW money to buy it!
- You make money with other people’s money – borrowed money and tenants helping to repay the bond
I prefer to always put property second when talking about asset classes. That is how it was when I grew up. It still makes sense to me. Property is the only asset class where I derive a cash flow that helps me to own the asset.
Think about it – cash investments come from your own pocket. That is why it is so difficult to build up. Stocks and shares comes from your own cash flow. That is why it takes time. Even if you reinvest the dividends, the dividend yields are very low.
With property, on the other hand, you buy an asset with borrowed money. You get returns on the full value of the property. This means you buy a $1oo ooo apartment (if you can find it) and get capital growth on $100 000. Perhaps you invested a $10 000 deposit. Yes, you have to repay the bond, but the tenant will help you with that and in time the rental will cover the bond repayment.
That is the thing with property – you acquire a valuable asset with very little investment from your own pocket.
STOCKS AND SHARES
Stocks and Shares are medium to long term investments.
This is where you can buy a share of good companies and share in their success.
There are different ways to invest in shares, depending on the money you have available and your knowledge.
The main goal with share investing is capital growth. Unlike properties, stocks are very liquid. There is always a market – buyers and sellers – and the price is immediately known. You can put in an offer to buy or sell and the transaction can be concluded almost immediately.
This is not an investment, it is trading. It is a zero sum game. It means when you lose, you lose everything. Gambling is a zero sum game. If you put $50 on a horse race and the horses loses (favorites in horse races only win about 33% of the time and the odds is such that you cannot make up the losses but just betting on the favorites), you lose $50.
BE CAREFUL WHEN YOU GO HERE
Derivatives are what the name says – it is making money on an instrument derived from another, underlying instrument. You do not buy the underlying asset, such as shares, you buy a derived contract based on changes in the price of the underlying asset.
Today the best know derivative is probably Forex trading.
These instrument are highly geared, that is why you make money with a small investment. The problem with gearing, is that it goes forward or backwards with the same ratio. It means that you can lose as much as you make!
Do not venture into derivatives without very good knowledge and experience.
Trading with derivatives can make you money – like all trading. Drop shipping is also trading, just not as risky. If you know what you do, you can generate good money. But most people lose money. If I can believe the statistics, it is the 20% of traders who make money who get the money of the 80% who lose money – it is always a zero sum game.
If you have not done so yet, read the post that I linked to – it is very important.
In fact, do not venture anywhere financially without good knowledge and guidance. Please do not rush out and start making all kinds of changes to your portfolio! After reading this, you should have an idea of asset classes and what they do and how they work. Now go to your financial/investment advisor and ask him or her what would be the best way forward for YOU. Remember, financial planning is not a one size fits all. Always, always, use a financial advisor to help you with your planning and implementation.